When should I incorporate my startup?
Nov 27, 2023
When in your startup journey should you incorporate a business?
Incorporating a business is a significant milestone in a startup's journey, marking its transition from an informal venture to a formal legal entity.
At Commenda, a lot of founders come to us asking at what stage of their startup journey they should incorporate an entity. This is not a small decision — especially for foreign founders where the process of setting up their corporate structure can cost months hundreds (even sometimes thousands!) of dollars.
We typically offer a few pieces of information, and figured it may be helpful to share them here in a public forum.
Liability and Professionalism
From the outset, one primary consideration is liability protection. Incorporating a business, whether as a Corporation or a Limited Liability Company (LLC), creates a legal separation between the owners' personal assets and the business's liabilities.
This protection becomes crucial as the startup begins to engage in contracts, hire employees, or if the nature of the business involves considerable risks. For instance, a tech startup developing a physical product might face liability issues that an online blog wouldn’t. Hence, the former should consider incorporating earlier.
Another early consideration is the aura of professionalism and credibility a formal business structure brings. Suppliers, customers, and potential partners often prefer dealing with a legal entity. This perception can be particularly important in B2B industries, where clients expect a certain level of formality and assurance.
Are you planning on Fundraising and what Structure may best facilitate that?
As the startup grows, its needs evolve. A critical juncture is when the startup looks to raise capital. Investors, especially venture capitalists and angel investors, typically prefer to invest in a corporation, particularly a C-Corporation, due to the favorable structure for equity shares and potential tax benefits.
As Peter Thiel once said:
“The worst thing ever is when people who aren’t yet a company pitch you for an investment. VCs are supposed to invest in companies, not create and build your company for you. Do not pitch until you’re a company. No one wants to get pitched just an idea or product. Even if VCs loved the product or idea, they literally can’t invest, because there’s nothing to fund. You need a company to wire the money to.”
The choice of entity – LLC, C-Corp, or S-Corp – depends on the startup's future goals. For instance, if the plan involves going public or raising substantial venture capital, a C-Corp might be the best choice, especially considering its favorable structure in the United States for these purposes.
The majority of US C-Corporations are in Delaware, and nearly all venture-backed startups in the US are domiciled in Delaware. That tends to be the default choice for tech companies.
Tax Considerations and Operational Complexity
Tax implications are also a key factor. Different corporate structures have varied tax treatments. For instance, C-Corps face double taxation on profits and dividends, whereas LLCs offer pass-through taxation.
However, these tax considerations should be weighed against the potential for reinvesting profits into the business, a common strategy for rapidly growing startups.
It's also important to recognize the increased operational complexity and administrative overhead that comes with incorporation.
This includes regulatory compliance, record-keeping, holding regular board meetings, and maintaining corporate formalities. Startups should ensure they have the capacity and resources to manage these requirements before deciding to incorporate.
Questions about the US Compliance Calendar? Book a call today.
Are there Industry-Specific Factors or Intellectual Property concerns?
Certain industries may have specific requirements or norms that dictate the timing of incorporation.
For instance, startups in regulated industries like healthcare or finance may need to incorporate earlier to comply with regulatory requirements. Similarly, if the startup's core value is rooted in intellectual property (IP), incorporating early can help in effectively managing and protecting these assets.
